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Monday, March 4, 2013

P/B Ratio

Hey there

So as promised, today I’m going to write a bit about what I know on price to book ratio (P/B ratio). Much
like P/E ratio, P/B ratio is an indicator that can be used by value investors
to signal if a company is under or overvalued. Also like the P/E ratio, it
should not be used alone to judge a value of a company, if a low P/B ratio consistently
points us to an undervalued company, we’ll all be rich.

To calculate the P/B ratio you divide the price per share
by the book value of the equity:

P/B ratio = Price per share/Book Value

Book value is the company’s assets minus its liabilities.

So from that formula, we can say that the P/B ratio
compares the current market valuation of a company to the value of the
company’s assets. A P/B ratio of less or equal to 3 typically interests value
inventors because it could mean that the stock is selling at a discount to its
fair value.

A company’s P/B ratio can be calculated including or
excluding its intangible assets and goodwill. A P/B ratio calculated without
intangible assets and goodwill should technically be called price to tangible
book value.

Personally, I like to look at the price to tangible book
value to get an idea of what might happen if the company that I'm deciding to invest in goes bankrupt. Obviously when a company goes bankrupt, one of the things they
can do is to break up the company into little packages and sell off their
assets in blocks to other people. By looking at the P/B ratio I sorta get an
idea of how much of a premium above the company’s assets I’m paying.

Thanks for reading, hope you’ve learnt something from the
post. Is the P/B ratio one of your favorite indicators? Or you don’t even look
at it. Do leave a comment or send me an email if you have anything to add. Next
week I’ll write about my first trade in 2013. Have a great week!